Investing in Real Estate through 1031 Exchange

In spite of the fact that many people remain a little gun-shy about real estate investments, the truth is that investment property remains a reliable, sustainable income generation source for those with the know-how on the ins-and-outs of how to play the “game.” While there are certainly several different ways in which investment properties can be used to generate income, the key to making this type of venture profitable really begins with maximizing your investment dollar in the purchase. Whether it applies to your current situation or to future real estate investment plans, understanding the process and benefits of investing in real estate through 1031 exchange can potentially save you a lot of money, helping you to stretch your investment dollars and maximize your profits.

What is a 1031 Exchange?

A 1031 Exchange is a program that allows the seller of a property to circumvent capital gains tax by reinvesting those dollars into an investment property.

How it Works

Investing in real estate through 1031 exchange must be arranged prior to the sale of an existing property in order for the seller to be exempt from capital gains. A professional agent is typically needed to facilitate the process. Upon closing of the sale, a predetermined amount of the proceeds will be set aside in a 1031 exchange account. Then the following schedule applies:

The seller has a time limit of 45 days from the first day after the closing of the sale in which to identify up to three investment properties. Ideally, you would have a written offer placed on these properties within the 45-day period, but there are other acceptable means of meeting the property identification requirements which can be explained in detail by your 1031 agent.

If no investment properties are properly identified within the 45-day window, the funds are returned to you, and once again subject to applicable capital gains tax rates.

There is a second schedule to be aware of with a 1031 Exchange which requires property acquisition within 180 days. Investment properties must be identified within the first 45 days, and then closed on within 180 days. All schedule requirements are based upon a start-date of the first day after the closing of the property which generated the 1031 exchange proceeds.

Qualifying Properties

As with most tax-related issues, different nuances may be present in different states. Additionally, the type of property you sell can be a determining factor in the type of property you are allowed to buy. As a general rule with the 1031 Exchange, the money must be spent on investment properties such as rentals. Different rules apply to rental property investments such as duplexes and apartment buildings, however, than those that apply to vacation rentals and the like. These differences can be explained in detail by your 1031 agent, and should be thoroughly understood in advance. Residential properties (in which you intend to live) also fall into their own category and should not be assumed as eligible 1031 Exchange properties.

In essence, investing in real estate through 1031 exchange is a valuable tool for maximizing your real estate investment dollar. It is imperative, however, that you get it touch with a qualified agent and gain a thorough understanding of the requirements as they apply to your particular location and situation.